Libyan Pipeline Explosion Portends Rising Security Risks to Oil Production

On December 26, a pipeline explosion disrupted flows from Waha Oil Company fields to the Es Sider terminal on Libya’s central coast.

Reports at the time of writing cite an initial loss of 90 MB/D, disrupting over one-third of recent loadings volumes from Es Sider. More importantly, the attack signals a worsening security environment in Libya, where a near doubling of crude production since April 2017 has caused complacent markets to overlook persistent risks to oil supply. In particular, ISIS and Al Qaeda continue to regroup with their eyes on oil infrastructure, and the former looks like the culprit in today’s incident. Meanwhile, the civil war shows no sign of slowing, so it may be a matter of time before the myriad of competing militias on the ground attempt to cut off oil revenues to their respective rivals. PIRA believes recent crude output around 1.0 MMB/D is near capacity, given technical and economic constraints, making production risks significantly greater to the downside.

Pipeline Supplies on Their Way Back to Normal as Outage Impact Reverberates

The natural tendency of the market would be to associate the recent spike in prices essentially to colder than normal temperatures. In reality, the reasons are broader, less seasonal, and potentially more sustainable when it comes to gas demand growth. A colder than normal start to December has driven another large step up in R/C demand and despite an increase in gas pricing, coal to gas switching is now well out of the money. As discussed last month, any available coal generation will already be running. Further adding to this constraint in the reserve capacity margin, low hydro stock levels throughout Europe mean that this largely flexible form of generation will be of limited ability in responding to only extreme spot price premiums (as we’ve been seeing in Italy).

Coal Prices End Year on a High Note

Coal prices again moved higher in December on cold weather in key Asian markets, strong LNG pricing, and generally low stockpiles. Upside pricing risks will continue to dominate during the peak demand season, although a downshift in dry bulk freight rates, and weaker demand fundamentals in 2018 will pull prices lower in 2H18.

Changing Global LNG Tanker Movements Reflect Market Urgency

Tanker speeds are reflecting how critically tight the LNG market really is and how midstream LNG traders are urgently capturing the market opportunity while it is still around. Generally, when modeling cargo movements one takes for granted the time from liquefaction to regasification terminal, using a speed of 19 knots. New tankers can go up to 21 knots, which is significantly faster than oil tankers that generally go between 15- to 20-knots. Recently, PIRA has noticed that tanker speeds have been gradually accelerating and reaching levels not seen in several years. In fact, we had seen years of slower movements until recently due to poorer demand growth and surplus tanker capacity.

Demand Ends the Year on a High Note

Demand continued increasing into year-end with solid gains posted by gasoline, jet, and gasoil demand. Runs increased 57 MB/D and reduced the amount of underutilized capacity, while crude stocks built 1.7 MMBbls on a higher import rate. Finished product stocks ended the year with a solid draw of 2.1 MMBbls. Gasoline demand rose 81 MBD to 910 MB/D, but was still a bit below expectations. Gasoil demand was higher by a strong 55 MB/D and outperformed expectations. Gasoil demand will plummet at end-year and some big shifts will occur in stocks as we enter the New Year. Kerosene demand was only modestly higher and is still seen as underperforming expectations, given much colder than normal weather. The stock draw rate accelerated from -37 MB/D to -100 MB/D. Implied refining margins eased, but remain good. Retail prices posted a fractional rise, while the indicative marketing margin improved on gasoline, but eased on gasoil/diesel. Gasoline is above norms, while gasoil/diesel is modestly below norms.

Credit Conditions End the Year on a Low Note

The S&P 500 fell back on the week after still trying to test the 2,700 level before year-end, but it wasn’t to be. The credit side of the picture remains increasingly selective. Implied inflation is starting to head noticeably higher, and along with that, there has been a solid move higher in energy, industrial metals, and to a lesser extent, precious metals. The dollar was lower by about -1.18%. There continues to be noted divergence between equity performance (S&P 500), credit (HYG), and a measure of the yield curve (10yr-2yr). The St. Louis financial stress indicator again moved higher from the record low set four weeks ago.

Optimism Abounds for 2018

As is typical, the New Year brings with it a plethora of market prognoses for agriculture, the majority of which seem to be in a desperate search for a positive price story. Although 2017 financial forecasts still lean towards the first “up year” since 2013 when net farm income peaked at over $120 billion, the fact remains that 2016 and 2017 levels most closely reflect those from 2009 at around $60 billion. With net incomes down ~50% from the peak for the past two years, a positive approach may seem to make the most sense but almost all of the prognosticators are relying on a supply shock to push prices higher rather than increased demand, despite calls for a weakening dollar in 2018.

Another Large Stock Decline

Overall commercial oil inventories fell 8.8 million barrels last week and are now 7% below year ago levels while four week average adjusted demand is 4.5%, or 0.9 MMB/D, higher than year ago levels. The stock decline was led by crude oil inventories falling 4.6 million barrels, of which 1.6 million was in Cushing. This week’s data should show an even larger crude stock decline of 9.1 million barrels with Cushing contributing 2.2 million barrels. This week’s product demand tends to be weak because of the holidays but PIRA believes that it will be stronger than usual because of a robust economy and very cold weather, thereby moderating the traditional stock builds in the major light products. Stepping back, the key feature in the 2017 U.S. oil data is the success of oil market rebalancing brought about by the OPEC/non-OPEC output cuts and strong demand.

NGL Prices Rally

U.S. NGL prices rallied this week on encouraging movements in the crude market and seasonal res/com demand pulling prices higher. Ethane prices rose throughout the week on news that steam cracker projects on the USCG are advancing. Propane prices began the week near 1.00/gal but settled lower at the end of the week. MB Propane was assessed at 98.89 cents/gal on Friday. Butane prices rose 5% from last week’s close, ending at 109.5 cents/gal, with the isobutane premium reaching 8.25 cents/gal. U.S. weekly propane/propylene stocks drew by 2.7 million barrels, closing the week of December 22 at 68.6 million barrels, according to EIA data. The withdrawals come amid elevated propane demand domestically and steady exports. Propane exports came off last week’s winter high of 1.2 million b/d to 0.92 million b/d. The four-week moving average for domestic demand rose to 1.38 million b/d, and the winter seasonal average (week ended October 6 to present) is 1.15 million b/d, in line with 2016’s 1.16 million b/d, but lower than the five-year average of 1.26 million b/d, likely a result of steam crackers shifting away from propane as a feedstock. Olefin prices strengthened with the front month MB ethylene price up 1.8% w/w to close at 28.5 cents/lb and the front month MB propylene price up 1.0% w/w to close at 49.5 cents/lb. Steam cracker feedstock margins were mixed with the lighter ends, ethane and propane, gaining while butane and natural gasoline retreated.

French Nuclear Slowly Restarts, but Upside Risks for Prices Remain

We see French prices for the balance of the winter staying firm, as nuclear remains below multi-year averages and export flows are set to stay strong, especially toward Italy, which is well priced in the low €60/MWh in 1Q 2018. We also see hydro-starved Spain returning to a more pronounced importing position during the first quarter. The emergence of gas infrastructure constraints across Western Europe has also introduced a new upside element, which could impact power flows in and out of France, ultimately reducing the system reliability at a time when French gas stocks themselves are down 30% year-over-year.

Growth Surprises to Upside: Texas Continues to Drive Production Growth in October

U.S. crude and condensate actuals for October 2017 came in at 9,658 MB/D, indicating growth of 160 MB/D month-on-month and 850 MB/D year-on-year. Growth in the Lower 48 states more than offset losses in the Gulf of Mexico resulting from Hurricane Nate. Texas growth again leads the production surge. The monthly figures suggest PIRA could be underestimating recent production in its December Reference Case outlook by some 300 MB/D.

Equity Markets End the Year on a Quiet Note

Global equity markets were modestly mixed on the week. The U.S. market was modestly lower, but small gains were posted in housing, utilities, energy, industrials and materials. International indices performed a bit better on the week with solid gains for Latin America and emerging markets. For the year, our global composite equity performance gained 22%, while Asia (+25.6%), and Europe (+24.6%) outperformed the Americas (+19%).

Saudi Arabia: The 2018 Budget Signals Stronger Oil Markets

The Kingdom of Saudi Arabia’s 2018 budget strives to narrow its deficit by 15% to 195 billion SAR ($52 billion USD), relying on higher oil revenues, faster growth in non-oil revenues, and limiting expenditure growth to only 5.6% (less than half the growth in revenues). The key to achieving the 2018 budget remains further oil price improvement, which has already reduced some pressure to maintain painful austerity measures. In 2017, the government delayed a second increase in domestic fuel prices, reinstated $5-15 billion of annual benefits to government employees, and announced a $19 billion stimulus package. For 2018, the Kingdom anticipates a second straight year of spending growth, while a balanced budget is not projected until 2023 (three years later than the previous target). The projected budget deficit of 7.3% is roughly in line with an IMF estimate from October, and is probably sustainable for now given nearly $500 billion in reserves and public debt below 20% of GDP. This should buy time to implement the broader economic reforms of Vision 2030, as long as oil prices stay relatively firm. The latter point will be supportive for oil markets in 2018, especially with the Aramco IPO targeted by the end of the year.

Mild Weather Defuses SoCal Gas Crisis

Western on-peak spot prices were mixed in December with modest gains at SP15 and Mid-Columbia and declines at NP15 and Palo Verde. Southern California averted gas curtailments as temperatures averaged above normal but the SoCal city gate market still rose by more than $1/MMBtu from November to average above $5/MMBtu. Prices at the SoCal border saw a slight m/m increase as did Sumas which benefited from localized cold weather. Other Western markets followed Gulf Coast spot prices lower with the latter falling to the $2.70s due to supply gains. . Below normal precipitation had little immediate impact on hydro output, but will if sustained in Q1. Downward revisions to gas prices and, potentially, runoff have brightened prospects for gas margins, particularly in the inland Southwest as incremental Permian supply flows into the region.

Low October Stock Build and Producer Stock Revision are Bullish Signals

On December 22, the EIA reported end-October EPS coal stockpiles of 141.2 MMst, a build of 1.6 MMst m/m as compared a 7.2 MMst average build over the most recent five-year period. PIRA now estimates that end-November and end-December EPS stocks sit 14% and 19% below the most recent five-year average. It is the second month in a row that coal stockpiles are flashing bullish short-term signals.

Saudi Arabia: Debt Markets and Higher Revenues Provide a Bridge to a Stronger Future

In releasing its 2018 government budget, the Kingdom of Saudi Arabia provided insight into its projected medium term fiscal balances through 2023. It appears a continued recovery in prices remains a critical component, as does a relatively steady oil production increase. In addition, reducing government subsidies remains a key component in restraining the pace of government spending and redirecting its focus, along with fostering the faster growth of the non-oil portion of the economy. Lastly, the Kingdom is increasingly utilizing the debt markets, both domestic and international, to cushion the rate of drawdown in foreign exchange reserves. Such a multifold strategy is designed to place the Kingdom on a stronger financial footing.

The information above is part of PIRA Energy Group's weekly Energy Market Recap - which alerts readers to PIRA’s current analysis of energy markets around the world as well as the key economic and political factors driving those markets. To read PIRA’s Market Recap first, subscribe to PIRA Perspectives here.

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